Using Safekeeping and Third-Party Custodian Services

The safety of public funds should be the primary objective of all governments. One of the most important protections and a control against fraud is the separation of the safekeeping and custody function from the investment function Investment policies should include a section regarding independent third-party safekeeping or custody of securities. By arranging to have securities held by a third party, governments can effectively minimize safekeeping or custodial risk in an investment transaction.

In a third-party safekeeping agreement, the government arranges for a firm other than the party that sold the investment to provide for the transfer and safekeeping of the securities. Financial firms should not serve as both government broker-dealer and custodian. Safekeeping represents a financial institution's obligation to act on behalf of the owner under the owner's control. Custody is a more clearly defined control position by the agent responding to the owner's requirements. Custody normally does not take place in the governmental entity's depository bank.

Investments should be settled in a delivery-versus-payment (DVP) basis. In this procedure, the buyer's payment for securities is due at the time of delivery. Security delivery and payment occur simultaneously. This practice ensures that no funds are at risk in an investment transaction as funds are not released until securities are delivered, ensuring the governmental entity has either money or securities at all times during the transaction.

Recommendation:

GFOA recommends that state and local governments utilize independent third-party custodians to safeguard their investments and protect against safekeeping/custodial risks.

To accomplish this goal, GFOA recommends that governmental entities:

competitively select third-party custodians and safekeeping agents

have safekeeping/custodial agreements reviewed by government legal counsel prior to execution

evidence their safekeeping or custodial relationship with a signed, written security agreement that is reviewed by counsel and establishes the firm as its agent

execute all investment transactions on a delivery-versus-payment basis